The Role of Credit Guarantee In Capital Relief under New Basel Accords 11 May 2016 Korea Credit Guarantee Fund (KODIT)

Contents 01. Credit Risk Mitigation 02. Prime Operational Factors

Credit Risk Mitigation 01 :

About us

Basel Ⅲ Key principles Capital requirements Leverage ratio Liquidity requirements

Risk Weight The key risk weight Type Risk Weight (Basel Ⅱ standardized approach) Sovereigns − 0 ~ 150% (differentiated by credit rate) * Republic of Korea : 0% Public Institutions − Equals to that of the government (if the loss is covered) − 20 ~ 150% (if the loss is not covered by the government) Banks Securities Companies − 20 ~ 150% (differentiated by credit rate) Corporates Cash − 0% Secured by commercial real estate − 100%

Legal Support Legal support for coverage of loss Korea Credit Guarantee Fund Act Article 41 (Coverage of Loss) ① In case where any profits are made in the closing, those profits shall be reserved in full. ② In case where any losses are incurred in the closing, they shall be covered by the reserve under Paragragh ①, and if the reserves are insufficient, the Government may cover them.

Risk Weight Conditions of guarantee to fulfill Basel requirement Uncondition al payment Explicit & documented obligation Irrevocable payment

Effect of Credit Guarantee Effect on capital adequacy ratio Credit Supply Increase Supplying additional credit by Improving capital adequacy ratio Indirect Effect Loan to SMEs which would not be eligible without CG Direct Effect

Effect of Credit Guarantee Path of indirect effect Reducing risk weight of the loan secured by credit guarantee Increasing Capital adequacy ratio of banks Banks get the effect of increase in equity without actual input of capital Step 1 Step 2 Step 4 Step 3 Supply additional credit to the market up to 12.5x of the increased capital

Effect of Credit Guarantee Empirical research result Direct effect Outstanding guaranteeAverage coverage ratio Loan secured by guarantee $ 26.3 B87.0 %$ 30.3 B Indirect effect Equity increase effectMinimum CAR Available amount of additional credit $ 2.4 B8 %$ 30.6 B Total amount of additional credit supply$ 60.9 B 1 USD = 1,140 KRW

Prime Operational Factors 02 : to ensure commitment of its liabilities

Integrated System for Soundness Four major criteria

Legal Support & Supervision Legal support Legal Basis Korea Credit Guarantee Fund Act Mandate Credit guarantee and relevant services Type of Entity Fund(no shareholder or ownership) Government Support Liquidity risk is covered by the government(by law)

Legal Support & Supervision Sound governance The Board of Policy The Board of Directors Budget planning Operation supervision Capital contribution

Financial Stability Sources of fund Government (irregular) Subject to yearly budget of the government Banks (regular) Mandatory donation in proportion to monthly balance of outstanding corporate loans of commercial banks Others (irregular) Occasional contributions from banks or large enterprises Guarantee Fee SMEs pay 0.5 ~ 3.0% of annual guarantee fee (upfront) Average fee rate : 1.27%(as of 2014)

Financial Stability Sources of fund Government (irregular) Subject to yearly budget of the government Banks (regular) Mandatory donation in proportion to monthly balance of outstanding corporate loans of commercial banks Korea Credit Guarantee Fund Act Article 6 ① The equity fund of KODIT shall be built up with resources falling under the followings: 1. Contributions from the government; 2. Contributions from financial institutions; 3. Contributions from enterprises; ③ Financial institutions shall make contributions to KODIT such amount by the rate as prescribed in the Ordinance of the Prime Ministry, within the scope of not exceeding 3/1000 per annum of their loans.

Financial Stability Source of fund Government (irregular) Subject to yearly budget of the government Banks (regular) Mandatory donation in proportion to monthly balance of outstanding corporate loans of commercial banks Others (irregular) Occasional contributions from banks or large enterprises Guarantee Fee SMEs pay 0.5 ~ 3.0% of annual guarantee fee (upfront) Average fee rate : 1.27%(as of 2014)

Operational Mechanism Guarantee procedure SME’s application Eligibility check-up by interview with owner Step 01 Document submitted & reviewed Analyst’s on-site visit Step 02 Credit rating & Evaluation Guarantee approval Step 03 Contract & Paying fee Issue of guarantee Step 04

Operational Mechanism Eligibility, ceiling & coverage

Risk Management Optimal enterprise risk management system

Risk Management CCRS(Corporate Credit Rating System) Credit Investigation Owner’s CB rating Combination of Model (Combined Score ) Combination of Model (Combined Score ) Pre-Rating Filtering CCRS Rating (Final) Quantitative Model Scores from Financial Factors Scores from Financial Factors Scores from Quantitative Factors Scores from Quantitative Factors Scores from Qualitative Factors Scores from Qualitative Factors Financial Model Qualitative Model Rating Median PD(%) KR1 KR2 KR3 KR

Leverage Ratio (1 USD = 1,140KRW)

Default Rate

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